Stumbling and Mumbling

Labour & the deficit

Don Paskini asks what Labour’s economic policy should be. Given that the party isn’t going to be in power until at least 2015, I’m not sure it needs detailed proposals at this stage. Instead, it needs some general principles. Here are some:
1. Distinguish between two ideas: “cuts in government spending will weaken the economy, relative to what would otherwise be the case” vs. “Cuts will plunge the economy into recession.” The first is very plausible - Duncan is entirely right to cite Kalecki - but the second is less so: it’s possible that the economy’s baseline growth would have been sufficiently high that it can withstand tighter fiscal policy.
It would, to paraphrase Alan Budd, be mad to stake one’s reputation upon an economic forecast.
2. It is an accounting fact that reducing government borrowing requires that the private sector’s financial surplus falls. This in turn requires that the banking system be fixed, so people can borrow more easily. David Miliband was therefore right to stress the need  for reforming the financial system - but he should have been more explicit that this must be a centrepiece of cutting the deficit.
3. The binding constraint on government borrowing is not the markets but inflation: the deficit can, in theory, be monetized. This doesn’t mean it should be fully monetized, as inflation might then bite. But it does mean we shouldn’t kowtow to the capricious gods of the market.
4. For now, neither the markets nor inflation require immediate cuts in the  deficit. The government therefore has time to think about a sensible reduction plan, and to canvass ideas from people who are not mentally ill. This is all the more true because, as Don says, some “cuts” can turn out to be counter-productive. To the question: “what would you do about the deficit?”, Labour should answer: “We’ll think about it properly, which would be an improvement.”
5. The idea that top-down government can identify efficiency savings has already been discredited.  Osborne’s first round of cuts - which should have been the low-hanging fruit of pure efficiency gains - included cuts of genuine services, such as university places. You can only achieve significant true efficiency gains by empowering workers, because it is only the boots on the ground who know where money is truly wasted. Such empowerment has the added virtue that it is the only way to avoid spending cuts becoming class war within the public sector.
6. There’s more room for tax rises than generally realized. As Martin Wolf points out, land tax has much to be said for it.
7. Macroeconomic policy on its own cannot achieve full employment (though it can prevent it!). Perhaps even - to cite Kalecki again - sustained full employment is impossible under capitalism. We shouldn’t, then, invest too much in macro policy.
Note for pedantic right-wingers; by cuts, I mean less government spending than would otherwise have been the case.

Collective vs individual decisions

Here is evidence that collective decision making is superior to individual decisions:

Our results indicate that teams (1) learn faster the solution to a reasoning problem than individuals; (2) need less specific (and weaker) performance feedback in doing so; (3) might even perform at a higher level than the best individuals.

See also this pdf and this.
This raises a question: if collective decision-making is superior to individual decision-making, why do we have a cult of the individual when it comes to appointing chief executives and party leaders? Why not have more collective leadership?
I can think of several answers:
1. My presumption is wrong. Many business and political decisions, though nominally attributed to CEOs or party leaders, are taken by a team in which the leader might be only primus inter pares.
2. Groups can get things as badly wrong as individuals. Laboratory experiments don’t show this, as they exclude the conditions - such people becoming close over time - which generate groupthink.
3. Having a single individual to praise or blame can sharpen incentives and so improve performance. I’m not sure about this, as high-powered incentives can often backfire.
4. Leadership is not just about decision-taking. It’s also about inspiring and motivating people. Individuals do this better than committees.
5. The cult of the individual is founded not in empirical data, but in ideology. The idea that some super-humans are able to take complex decisions is just a myth used to justify what is in fact rent-extraction by bosses.
Should we really put a non-zero weight on (5)?

Scrapping the retirement age: two analogies

Should firms be free to sack workers who are short or ugly? The answer is yes, if you support the CBI’s opposition to the government’s decision to scrap the default retirement age.
The case for firms forcibly retiring 65-year-olds is that these tend to be less productive (pdf) than younger workers.
But there’s also good evidence that shorter and uglier workers are less productive too. So, if firms are free to fire 65-year-olds, why shouldn’t they be free to fire stumpies and munters?
You might reply that these are only slightly less productive than taller, prettier workers; that the differences are largely compensated for by lower wages; and that lots of short or ugly people are very productive.
True. But exactly the same applies to older workers.
The government’s decision to crack down on the sacking of older workers should, then, be welcomed on the grounds of consistency; there’s no strong reason to treat wrinkles differently from munters.
However, just as there’s an inconsistency in the CBI’s argument, so too is there one in the government’s position.
On the Today programme, John Humphrys suggested to Ed Davey that allowing older folk to work longer would deprive younger workers of job opportunities. Mr Davey replied:

Older people and younger workers aren’t substitutes. They complement each other. If we have people working longer…that will result in a stimulus to the economy. I think that will lead to more jobs overall. I don’t buy this idea that there’s a fixed number of jobs in the economy.

Good answer. But it is exactly the one used by opponents of a cap on immigration. We claim that immigrants are (with exceptions) complements, not substitutes (pdf), for many workers, and that they stimulate the economy.
In fact, you can think of older workers joining the labour market as a form of immigration - people migrate from retirement into the labour market. Why is the government so relaxed about this form of migration, but not about migration from other countries into the labour market? (I know, Ed Davey is a Lib Dem and so opposed to immigration caps, but my point holds.)
You could argue that older workers are, overall,  less of a substitute for native younger workers than are immigrants. But again, we are entering the realm of very fine distinctions indeed, for which the empirical evidence is weak.
So, could it be that both the government and CBI are being a little inconsistent?

Inequality & the crisis

Was rising inequality to blame for the financial crisis? Two things I’ve seen recently suggest so.
Raghuram Rajan says in Fault Lines that “the political response to rising inequality [in the US]…was to expand lending to households, especially low-income ones.” And Jean-Paul Fitoussi and Francesco Saraceno claim (pdf) that increasing inequality involved a shift in income from people with a high propensity to consume to people with a low propensity, and this created a tendency towards weak aggregate demand which in turn led to low interest rates and asset price bubbles.
Personally, I’m a little sceptical here. Rajan’s argument seems crudely functional; I’d rather stress that lower- income people borrowed heavily in an attempt to keep up with the Jones’. And Fitoussi and Saraceno give us no evidence on the size of the demand shortfall created by increased inequality.
I suspect, though, that inequality matters in other ways.
First, a major cause of inequality was also a cause of the crisis. Ravi Jagannathan and colleagues say the crisis (pdf) originated with the increased labour supply coming from China in the late 90s. This at least contributed to increasing inequality in the west. And it led to the crisis by giving China a huge current account surplus, which it tried to recycle into AAA-rated securities, which in turn fuelled the demand for mortgage derivatives. In this sense, equality might not have caused the crisis, but it was on the scene of the crime.
And it might have been one of the villains in another sense. One of the ideological justifications for “winner-take-all” inequalities was that top bosses had the skill to “add value” to huge companies. This contributed to a combination of over-confident bosses and a lack of adequate control of them - what Nick calls a “dictatorship of the manageriat“ - which  bred the poor corporate governance that destroyed some banks.
So, maybe inequality did generate the crisis - not (just?) through macroeconomic channels, but through an ideological one.

Land of the deluded?

The Economist has a depressing report on the US’s sky-high incarceration rate:

Between 2.3m and 2.4m Americans are behind bars, roughly one in every 100 adults. If those on parole or probation are included, one adult in 31 is under “correctional” supervision…
Many laws, especially federal ones, are so vaguely written that people cannot easily tell whether they have broken them…
There are over 4,000 federal crimes, and many times that number of regulations that carry criminal penalties. When analysts at the Congressional Research Service tried to count the number of separate offences on the books, they were forced to give up, exhausted. Rules concerning corporate governance or the environment are often impossible to understand, yet breaking them can land you in prison.

This raises a question: given this, why do so many Americans think they live in the land of the free?* Low taxes don’t get us far towards an explanation. The OECD recently estimated that the tax burden on the average American worker was higher than that in Switzerland, Australia, Japan and Korea and only slightly less than in Canada.
Could it be that cognitive biases are to blame? I mean three things:
1. Bayesian conservatism. For years, the US was a free country. As it became less so, people did not update their beliefs accordingly. Opinions can live on after the facts behind them have died.
2. Social proof. As Solomon Asch demonstrated in the 1950s, many people believe what other people tell them rather than the evidence of their own eyes. If millions of people say that the US is a free country, others will fall into believing this; Timur Kuran has written on a similar theme.
3. The optimism bias. Americans - or at least the white ones - are selected for their optimism; you don’t leave home and sail 3000 miles unless you tend to look on the bright side, and this optimism can be transmitted down the generations by nature or nurture. This bias leads people to underestimate their chances of falling foul of fickle laws, and overestimate their chances of living a free life.
There’s a parallel here to a curious fact pointed out by Raghuram Rajan - that 71% of Americans think the poor have a good chance of escaping poverty, whilst only 40% of European do - despite the fact that social mobility is lower in the US than in much of Europe.
I mention all this to raise a point which is often overlooked. Very often, cognitive biases are seen as mere levers with which to implement tricksy policies. However, such biases might play a larger role, as some guy pointed out in the 19th century. They can help to support and sustain entire social orders even if these leave a lot to be desired.
* I'm assuming this is the case. Intuitively, I get the impression that Americans are much more likely to take pride in saying things like "this is a free country" than are, say, Australians, Brits or the Dutch.

Osborne's unwise words

George Osborne says something odd here:

Today's figures show the private sector contributing all but 0.1% of the growth in the second quarter, and put beyond doubt that it was right to begin acting on the deficit now.

I fear this claim owes more to the confirmation bias than anything else. I fear it's unwise in three ways:
1. The government’s contribution to this growth was greater than 0.1 percentage points. Yes, "government and other services" contributed only 0.2 percentage points to growth. But the growth in other sectors was in part the result of increased public spending. For example, construction output rose 6.6%, adding 0.4 percentage points. But over 40% of construction output is public sector work (tables 3a and b of this pdf). And I suspect a chunk of the growth in manufacturing and other services was government-contracted work.
These figures don’t provide much evidence that the private sector is strong enough to take a fiscal tightening.
2. In neither his Budget nor his election campaign did Osborne argue that a fiscal tightening was justified because of the strength of the economy. To link the wisdom of such tightening now to the health of the economy is to create a hostage to fortune. If growth slows, Osborne’s opponents will say: “If it was right to cut the deficit when the economy was strong, it’s wrong to cut it now it’s weak.”
3. And this fortune could well turn. Pretty much all economists agree that growth will slow markedly from Q2’s 1.1%.
It’s quite common for GDP to rise strongly early in a recovery, only for growth to moderate later - partly because an ending of inventory cutbacks can give a one-off boost to growth. For example, in 1981Q3, GDP leapt by 1.4%. But GDP grew a mere 2% over the following four quarters, and unemployment continued to soar.
We shouldn’t, then, infer from these numbers alone that the government should cut spending now.

A squealing leftie writes

Tim says something that puzzles me:

Human beings really are status seeking beings. The method of ranking it, enforcing it, discovering it, may change, but that there will be a social hierarchy is a given. And that’s the bit that our squealing lefties seem to forget….
Simply because we are human beings there is always going to be inequality of status within the society. For that is what we humans do, seek and acquire status.

Well, it's not part of my human nature. For as long as I can remember, I’ve hated hierarchies. I didn’t like school, for example, until I entered the less hierarchical sixth-form. One reason I wouldn’t want to be an academic or  civil servant is that I’d be uncomfortable with their endless gradations of status. I cringe whenever I hear the adjective “distinguished“. I despise awards. I’ve long thought that anyone in any position of power or authority is a cunt  (to put it more mildly would be to lie) - a view not shaken by yesterday’s news.
Now, amateur psychoanalysts might attribute this to my family upbringing. But am I really so unusual? I suspect perhaps not, for three reasons.
First, thousands of people do rebel against hierarchy. But they do so through crime, anti-social behaviour and “bad attitudes”, and so their views are treated as a social problem rather than an expression of legitimate beliefs; I suspect much of the difference between me and Wayne is merely that I intellectualize my problem with authority.
Secondly, in some cases - though perhaps fewer than we think - hierarchy is an efficient way of organizing things. As Norm says, we should distinguish between supporting hierarchies for functional reasons and supporting them because we inherently like them.
Thirdly, some (much?) of the disquiet with hierarchy might take the form of what looks like status-seeking behaviour. Some people want to be boss not (just?) because of the status it confers, but because they feel that being the boss will give them an autonomy they don’t have lower down the hierarchy. Status-seeking behaviour will in such cases be observationally equivalent to autonomy-seeking behaviour.
What we have here could be a problem of collective action. Let’s say - for the sake of argument - that some form of egalitarian organization would be better than a hierarchical form. Would we then move to the egalitarian form?
Not necessarily. To make this shift, we have to act collectively. But doing this is tricky; there’s the free-rider problem. In many cases, then, individuals will instead try to climb up the hierarchy. Such behaviour might be rational maximizing by each individual, but not necessarily rational maximizing for all individuals.
And it might not even be the former. The optimism bias might work in two ways here: people over-rate both their chances of becoming top-dog and the satisfaction they‘ll derive from it. This causes them to over-invest in either status-seeking behaviour or things that look like this.
Of course, if Tim is saying that inequalities of status are damned hard to remove, I’ll agree. But if he’s saying that such inequalities are hard-wired into our nature, or are somehow good for us, I’ll quibble.

Labour's trilemma

How should we think about the Labour leadership election? If we want to go beyond a vapid personality contest, here’s one way - to use a simple Venn diagram.
Historically - and still today - the Labour party has faced a three-fold task: to find policies which are egalitarian (in some conception), economically efficient (in some way), and electorally popular. In his youth, David Miliband edited a book suggesting just some possibilities here.
But there are - and always have been - conflicts between these three criteria*. This is represented in my Venn diagram. Some policies are egalitarian but not popular or efficient, for example, a tax and benefit system that perfectly equalizes incomes. Others are egalitarian and efficient but not popular (area B in my chart): I’d argue that a citizens basic income and policies to promote workers’ control are in this category. And so on.
From this perspective, the leadership contenders face two challenges:
1. What policies fall into area D - that is, are efficient, egalitarian and popular? The difficulty here is that these policies are like low-hanging fruit. Many of them (state pensions? The NHS?) have already been implemented. What others are there? I’d look at the work of James Heckman, who shows the importance of interventions in a child’s early development. Policies along these lines are efficient (they increase skills); egalitarian (they can improve the life chances of the very worst off if done properly; and popular (help with child care!). It's possible, though, that I've misdrawn the diagram and that area D is in fact an empty set.
2. Is it possible to move the circles to create a greater overlap? If Andy Burnham’s talk of “aspirational socialism” has any substance, it might be as an effort to redefine egalitarianism to give it more overlap with popularity and/or efficiency.
However, another option is to shift the popularity circle. Sadly, however, the leadership contenders seem to think that vague talk about reconnecting with the electorate is sufficient here. It’s not. The question is not: what individual‘s ego can move the circle, but what mechanisms might do so? I would think along the lines of building client groups here - of asking: how can we ensure that more people perceive it to be in their interest to support policies that are (somehow) egalitarian and efficient. This is a huge question, which touches upon cognitive biases as well as policy design. And I’m not sure it’s being asked, let alone answered. 
* And of course, within them because different conceptions of equality conflict. But let's keep things simple.

The OBR problem

Not for the first time in his life, Alan Budd has blurted out a truth:

I of course wasn't in my right mind when I took this job. No-one in their right mind would take a job where your success is going to be judged on your success in producing fiscal forecasts.

This raises the question. What can be done to ameliorate this problem? I can think of three possibilities.
1. The OBR shouldn’t provide point forecasts at all, but simply probability ranges. So, for example, it would say: “there is a 50-50 chance of PSNB being between £134bn and £164bn in 2010-11, and a 25% chance of it being less than £134bn and of being more than £164bn.”
This would, of course, require the OBR to teach journalists about the fact that uncertainty is a large and ineradicable fact about the future. Having seen Mervyn King bash his head against this brick wall for years, I wouldn’t fancy taking this job.
2.  It could take the ego out of forecasts. Rather than present a single forecast, it could present a range of forecasts that arise from competing models of the economy, and discuss why they vary. This is the sort of job the ESRC’s macroeconomic modelling bureau did, until it was shut down.
The problem here, though, is that one important model would present government borrowing as (largely) a passive response to private sector saving and investment decisions. Would the government really want the OBR to draw attention to this possibility?
3. Fiscal policy could become less dependent upon forecasts. One possibility here is to make the automatic stabilizers more powerful. For example, if marginal tax rates were higher, taxes would fall more in a slump and rise more in a boom, so fiscal policy would stabilize activity without the use of government discretion. This though, might run into the problem, that there is a trade-off between short-run stabilization and promoting long-run growth.
An alternative is to have a state-dependent rule for tax rates - of the form, “tax rates will rise by x percentage points if GDP growth is above y, and fall by x percentage points if growth is below z.” Of course, this means fiscal policy would only respond to the reality of booms and slumps, rather than to expectations thereof, but it’s not obvious how much worse this would be than existing arrangements.
The big problem with this is rather that it takes (some) discretionary fiscal policy out of the hands of government.
I don’t know if there is a “politically acceptable” solution here. But let’s be grateful to Alan Budd for raising an important issue - that, in fiscal policy, there is something inadequate about a “predict and control” mentality, when predictions are so prone to go badly awry.

Renting friends: instinct vs economics

The great Porter Wagoner sang: “Money can’t buy back your youth when your old or a friend when your lonely.”
He’s wrong now - at least about the latter. In the UK, we’ll soon be able to rent friends. This raises an interesting clash between our instincts and economics.
My first reaction to this - well, second, after “have they got a mandolin-playing Marxist who looks like Emily Procter?” - was: “Eeurgh.” Renting a friend is oxymoronic. The very definition of friendship is a relationship in which money doesn’t change hands. Friendship, surely, is (or should be) subject to what Michael Walzer called a “blocked exchange” - it's something that can’t be exchanged for cash. Indeed, my instinct is that renting a friend is much creepier than paying for sex.
Economics, however, has a different take.
First, happiness research tells us that friendships are tremendously valuable in improving our well-being. Nattavudh Powdthavee has put a price on this (pdf). He estimates that the happiness we get from meeting a friend once a week rather than less than once a month is equivalent to an additional income of £47,400 a year; this seems like a huge sum partly because income doesn’t make us very much happier.
Now of course, a rented friend (schmiend?) would give us less utility than a genuine friend. But even if we discount this sum very heavily, there are still potentially significant gains from us widening our social circle.
Secondly, in finding friends we face informational problems. I just don’t know where to find the MPMWLLEP. This lack of information means that the market in friends is thinner than it would otherwise be. And it’s trivially true that a virtue of the web is that it can increase  information and hence the thickness of markets - hence the success of eBay, rightmove and GoCompare, among many others.
Put these two facts together, and there is potential for rent a friend to be a success.
Which raises the question: which will win out: instinct or economics?